US 20080172325 A1
This invention provides systems, methods, and designs for a novel financial product which provides many lifecycle investment advantages compared to existing state of the art products currently available.
1. A method, system, and financial product for efficient lifecycle investing, comprising the step of:
identifying suitable borrowers for a novel financial product called a bundled reverse mortgage, specifying the terms upon which the proceeds of the bundled reverse mortgage are to be paid, selecting a strike price for a home mortality put option to be bundled with the reverse mortgage, selection long term care insurance to be bundled with the reverse mortgage, and obtaining the consent to purchase and purchasing on the life or lives of each respective reverse mortgage borrower a policy of life insurance.
The present invention relates generally to systems, methods, plans and products for designing and providing financial products which are both investment, consumption, and tax efficient across the lifecycle of an individual. In the theory of financial economics, lifecycle investing and consumption involves systematic investment and consumption planning throughout an individual's entire lifecycle in order to help best achieve one's financial objectives and goals. According to the well known Lifecycle Investment Theory of Nobel laureate Franco Modigliani, every individual passes through distinct stages in his lifecycle which are defined by characteristic and differing marginal utilities for saving and consumption. The first characteristic stage is the accumulation phase, during which an individual has higher marginal utility for consumption but constrained or limited resources. This phase is marked by dissaving by the individual, as he spends more by way of loans than he earns to meet his multiple needs. The second characteristic phase in an individual's lifecycle is the consolidation phase wherein the individual has satisfied most of his essential needs and is looking at opportunities of incremental wealth generation. This phase is marked by a higher marginal utility of wealth currently or, in other words, an intertemporal substitution of consumption whereby deferred consumption is deemed to have higher utility. In this stage, individuals typically exhibit net saving. The third and fourth phases are often referred to as the spending and gifting stages, respectively. These phases are again marked by dissaving as an individual eats into his earlier savings to meet up with his remaining lifecycle. As an individual evolves through these stages in his lifecycle, not only do his financial objectives and goals change, but also his risk bearing ability, which largely determines the feasible set of investment choices at each stage. The aim of the present invention is to provide novel methods, systems and products for lifecycle investment and consumption which efficiently achieve these changing investment goals. Throughout the description of this invention the term efficiency includes both market or pure investment efficiency which is a function of the expected returns and volatilities of the feasible set of investment choices, and tax efficiency, which refers to providing investment methods, systems, and products which produce a large after-tax source of wealth under the U.S. Internal Revenue Code.
A number of uses for life insurance products have emerged in recent years to fulfill many lifecycle investment objectives. Various types of life insurance and annuity products have a dual savings and bequest objective which reflect the demand for deferred consumption in one's own lifetime and for the lifetime of one's beneficiaries. Recent innovations, such as variable universal life (VUL) insurance, bundle investment accounts together with yearly renewable term insurance. In this product, individuals may invest in a range of securities, mutual funds, or other types of investment partnerships in segregated investment accounts. The accounts are nominally owned by the issuing life insurance company. As a consequence, the owner of a variable universal life insurance policy pays no current income tax on investment returns. The death benefit of a VUL policy will generally increase as positive investment returns are accumulated. If the individual dies, this increased death benefit is paid out free of income tax to the VUL policy's beneficiaries. If the owner of the policy makes a withdrawal from the VUL policy prior to death, ordinary income tax is due on any earnings in the policy. Thus, a VUL policy bundles together the following components: (1) tax preferred growth of assets for either the individual (tax deferred withdrawals) or the individual's beneficiaries (tax free death benefits); (2) a layer of yearly renewable term insurance which is responsive to the overall growth in the investment accounts; (3) a mechanism by which the layer of term insurance can be paid for with before tax dollars through automatic deductions in the investment accounts.
A VUL policy is therefore a bundle of what financial economists call contingent claims. A pure contingent claim is a non-interest bearing security which pays out a unit of account (i.e., a dollar) should a given state of the world occur. For example, pure term life insurance pays out a certain quantity of dollars upon the death of an individual. Financial economists generally recognize that it is preferable to have a complete set of elementary (i.e., unbundles) contingent claims from which individuals can choose to fulfill their lifecycle investment objectives. (See, e.g., Lange and Economides, “A Parimutuel Market Microstructure for Contingent Claims,” European Financial Management, vol. 11:1, January 2005, and references cited therein). It is also generally recognized that bundling of contingent claims is generally a redundant exercise, however, bundling may be advantageous due to transaction cost and tax efficiency. For example, a VUL policy is a bundling of a tax deferred investment account and a term life insurance policy. An individual might be able to achieve the same objectives satisfied by a VUL policy by investing in a tax deferred 401(k) account and buying yearly renewable term insurance. Prima facie, the combination of the 401 (k) and the term insurance appears to achieve the same objectives as the VUL policy: tax free accumulation of investment returns available for withdrawal at a future date and an income tax free death benefit for beneficiaries. However, the VUL policy dominates for two reasons. First, were an individual to attempt to replicate a VUL policy with a 401(k) account and yearly renewable term insurance, they would find that the premiums paid on the term insurance must be made from after tax dollars. Section 264 of the Internal Revenue Code provides that these premiums are not tax deductible. In the VUL policy, by contrast, the premiums which keep the insurance portion of the VUL policy in force are automatically deducted on a monthly basis from the investment account. To the extent the investment account has returns, the premiums for the insurance are paid with pre-tax dollars since the returns from the VUL policy investment accounts accrue free of income tax. Second, replicating the VUL policy with a 401(k) and yearly renewable term insurance will incur significant transaction costs as the individual must dynamically “rebalance” the ratio of the balance in the 401 (k) versus the amount of term insurance. The VUL policy does this type of rebalancing automatically according to well-known and relatively efficient procedures. There is, however, a cost to bundling in the VUL policy: the Internal Revenue Code requires a minimum ratio of insurance to the balance in the VUL investment account in order for the VUL policy to meet the definition of insurance under Title 26, Section 7702. If this minimum ratio is requirement is not met, then the investment account returns will not receive the benefit of tax-free accumulation and the death benefit will be free from income tax.
In the spending and gifting phases of the lifecycle investment theory, an individual would typically optimally reduce his exposure to the riskiest of asset classes and, at some later point in his lifecycle, begin to annuitize a large portion of his wealth. The portion of assets exposed to risky assets classes, the level of such risk, the amount of wealth annuitized largely depend upon the individual's utility for current consumption and his utility for estate preservation—what economists typically call a “bequest motive” since it refers to a utility function “beyond the grave” to preserve assets for the next generation via bequest (or, equivalently, gifts late in an individual's lifetime). While a VUL policy can allow an individual to reallocate away from risk assets at this state in life and also annuitize part of his wealth, a VUL product's death benefit and the performance of its underlying investments are highly correlated. That is, if the segregated account assets of a VUL policy fail to perform adequately, there may not be sufficient funds in the VUL policy to keep the death benefit in force through ongoing payments of the policy's cost of insurance. Additionally, variable annuities—both deferred and immediate—suffer from the same drawbacks. Investment performance is uncertain, thereby exposing the individual to both consumption and bequest risk. Non-variable immediate annuities, which bear substantial interest rate risk for the individual, also suffer from the imposition of a relatively high rate of immediate and deferred taxation. Through the expected lifespan of an individual a substantial portion of these fixed immediate annuities (SPIAs) are taxed. After the individual reaches his expected lifespan, the entire annuity payment is taxed.
As the portion of the population in the United States aged 65 and older is expected to double to 70 million in the year 2030, there is a growing demographic need to provide funded and tax efficient Long Term Care Insurance (LTC). In 2005, for example, legislation is pending before the U.S. Congress to provide a bundled annuity and LTC product which provides tax favored LTC benefits when such benefits are paid as part of an annuity product.
Another strong demographic trend emerging in the beginning of the 21st century is the large amount of home equity held by persons in the aging demographic. Current estimates of unencumbered home equity held by persons in the United States aged 65 and over range from 1 trillion to 2 trillion dollars. Such wealth is held in illiquid form not amenable to easy conversion into an efficient lifecycle and consumption plan.
A product that has emerged which attempts to convert the vast holdings of older Americans into liquid annuity cashflows is the reverse mortgage (RM). An RM is a non-recourse loan to an individual who owns substantial unencumbered home equity. The loan is provided to the individual against a first mortgage lien on the individual's home. The individual RM borrower can receive loan proceeds in either a lump sum payment, annuity payments for a certain period or for life, or in the form of discretionary payments similar to those that can be obtained with a home equity line of credit (HELOC). All principal and interest payments are due upon the death of the homeowner (or the last surviving homeowner, if applicable and if both homeowners are borrowers under the RM). The individual receives all RM proceeds free of tax. Upon death, the individual's estate receives a tax deduction for interest paid on the RM.
As can be seen in the below graph, RM origination has grown steadily from 2000 to 2004:
The above graph shows the growth in RM loans originated through the FHA Home Equity Conversion (HECM) program.
A number of disadvantages currently inhibit the growth of RM originations and their efficient lifecycle use by individuals. First, the conventional RM is very risky to the lender since the lender bears substantial longevity and real estate value risk. If the individual lives well beyond life expectancy calculated when the RM loan was originated and if home values do not keep appreciating at a reasonably high rate, the lender will not be able to recover all principal and interest due upon the death of the borrower because the RM, unlike conventional mortgage products, is non-recourse. Thus, the loan rate and other fees charged the borrower on existing RM products are very high and have impeded substantial growth. A need therefore exists for a new RM product which a lender an issue at a lower cost to the borrower which, at the same time, addresses the economic risks to the lender in offering the RM at lower cost.
Second, traditional RM products do not address the growing need for LTC insurance, as noted above. While existing RM products do provide liquidity for borrowers to independently purchase LTC insurance, the efficiency of LTC coverage can be enhanced greatly and provided with much less cost when bundles as part of a large lender sponsored RM product. In addition, individuals may not act fully rationally when allocating RM proceeds to other needs and the LTC need may not be addressed at all. Thus, a need exists for a new RM product, and systems and methods therefor, to provide both liquidity for existing stores of home equity and automatic bundled provision of LTC insurance at low cost.
Third, individuals have been reluctant to embrace current costly RM products since such products may, in future weak real estate markets, cannibalize all or most of the individual's home equity. While RM's are designed to effectively annuitize home equity, the risk exists that upon the RM borrower's death that temporary weakness in the borrower's real estate market would force a “fire sale” of the home to cover the accrued RM interest and principal, thereby greatly reducing the borrower's estate and thwarting his bequest motives. A need therefore exists for a new RM product, and systems and methods therefor, which provides the RM borrower a guaranteed and favorable source of liquidity for his home so that the RM loan principal and interest can be paid back to the lender without the risk of a disadvantageous sale of the home by the borrower's estate.
It is therefore an aim of the present invention to provide an RM lifecycle financial product in which (1) an individual can annuitize existing home equity at lower cost (2) receive LTC insurance efficiently bundled with the RM product; (3) provides the RM lender greater collateral security in making the RM loan in order to provide the RM to borrowers at costs lower than currently available and (4) provides a guaranteed source of liquidity to the borrower to repay the RM loan and accrued interest upon death.
For all these reasons and others, there is a need for a new RM financial product which, in a preferred embodiment, has the following characteristics:
(1) a right to receive a lump sum, annuity or discretionary payments from a lender in return for a first mortgage lien with no principal or interest payments due until the death of a selected homeowner, where said interest and other fees on such a loan is lower than that currently available;
The present invention provides methods, systems and products to solve the following problems or deficiencies facing an individual who desires make optimal lifecycle investment and consumption decisions by utilizing home equity and an optimal reverse mortgage loan:
The aim of the present invention is to solve these problems by providing methods, systems and products which accomplish these investment and insurance objectives.
A need is recognized for a new RM product which is less costly to the borrower. A need is recognized to reduce the overall borrowing cost to the borrower through reduction of RM loan risk to the lender and through reduction of origination costs.
A need is recognized to reduce risk to the lender by having the lender underwrite lender owned life insurance on one or more RM borrowers.
A need is recognized for a new RM product which provides a bundled source of liquidity for the homeowner upon death whereby the homeowner has the right but not necessarily the obligation to sell his home back to the lender upon the death of a specified homeowner.
A need is recognized for an RM product which combines shared home appreciation features to further reduce the interest cost to borrowers.
A need is recognized for a cost efficient bundling of LTC insurance with an RM product in order to satisfy the demand, at efficient cost, for LTC insurance among the population of RM borrowers.
According to one embodiment of the present invention, as described herein, a method, system and product for bundles reverse mortgage product (BRM) comprises the steps of:
The present invention is described in relation to systems, methods, products and plans for the enablement of a novel lifecycle financial contract and product. The product, described above and named BRM for the purposes of the present invention, is a novel reverse mortgage product which provides the following benefits: (1) provides the borrower with lifecycle consumption opportunities for the annuitization of stored household wealth in the form of home equity; (2) provides the borrower bundled long term care insurance protection which pays the borrower a defined benefit should the borrower's health decline to the extent the borrower or borrowers would qualify for the LTC benefits; (3) provides the borrower risk management and home equity protection via the bundling of a mortality put on the home of the borrower or borrowers entitling the borrower or other home occupant to sell the home back to the lender upon the death of one or more home occupants at a specified price; (4) provides for life insurance to be originated and owned by the lender so as to provide additional collateral support for the BRM so that same can be offered at more attractive terms to the borrower or borrowers. Additional steps of the methods and systems relating to the offering of the BRM include, but are not limited to the following: (a) obtaining the current value of the home to serve as collateral under the BRM; (b) determination of the actuarial expected life span of the borrower or borrowers under the BRM; (3) selection of an appropriate loan rate under the BRM commensurate with the expected duration of the loan, credit profile of the borrower, quality of the home collateral, interest rate market conditions, and other factors; (4) computation of the BRM loan limit as a function of the expected life span of the borrower or borrowers and credit and collateral related factors; (5) selection of a bundled LTC policy for the borrower or borrowers; (6) determination of the strike price of the mortality put upon the death of the borrower, borrowers, or other home occupants as a function of the current home value, the expected appreciation of the home, the expected life span of the relevant life or lives upon which the mortality put is contingent, the ratio of appraised value to market value of the home and other factors; (7) obtaining the consent of the borrower or borrowers for the lender to obtain life insurance on their respective lives; (8) optimal selection and design of the life insurance to be obtained by the lender, such selection, in a preferred embodiment, to be based upon the age of the insureds, the state in which the insured resides, the type of policy to be purchased, whether the premium is guaranteed or not, the structure of death benefits over time (e.g., whether increasing or not), the timing of premium payments to be made to fund the policy or policies and other factors.
Typically, states except life insurance in connection with credit transactions based upon the duration of the loan (e.g., 10 or 15 years), where the insured does not pay for the policy, or where the loan is a first mortgage loan. Thus, for states with these exceptions life insurance originated in connection with RM lending will not be subject to the statutes. Referring again to
As an example of the loan limit determination, the following assumptions and calculations, in a preferred embodiment example:
In the above example, the loan limit of $158,287 is the amount, which, when compounded annually at the loan rate of 7% to the life expectancy of each borrower, grows to the current home value of $500,000. Alternatively, a second to die lifespan longer than 17 years could have been used which would have resulted in a lower loan rate. Different combinations of these principles, as is apparent to one skilled in the art, will lead to different loan limits.
Referring again to
Referring again to
Referring again to
Referring again to
Referring again to
Referring again to
Referring now to
Referring again to
qt,T=the probability of death between time t and T, conditional upon survival to time t
As is commonly used, if the period of death and survival is taken to be a calendar year, the shorthand, qt and pt will be used respectively, where the second subscript, T, is implicitly understood to be equal to t+1 year. So, for example, q65 is the probability that a 65 year old of a given risk class (make, nonsmoker, select) dies in the next calendar year while p65 is the probability that a 65 year old of a given risk class survives in the next year. For step 210 of
As can be seen, the mortality charges increase with age at an increasing rate. As is known to one skilled in the art, there are relationships between the annual probabilities of death and the survival probabilities as follows:
That is, the probability of surviving from time t to T is the product of one minus the probability of dying in each year from t to T. For the above “hazard rates” derived from the 2001 Select VBT table, the probability distribution for the death of a select 65 year old male nonsmoker (select in the sense that this individual qualifies for life insurance) is as follows:
In a preferred embodiment, a mortality distribution such as that of Table 2 can be used with a model of the BRM loan assets under the CPMP so that the expected net present value of the balance sheet of the BRM entity can be obtained.
Referring again to
For ease of exposition, we will assume that there are 100 actual or prospective purchasers of mortality puts and that the average purchaser is a 65 year old nonsmoking male that is able to qualify for life insurance. The first step, following the data acquisition step of
In a preferred embodiment, standard uniform random variables can be used with the above probabilities (or using the force of mortality or hazard rates with the surviving cohort) to model the number of statistical deaths in each year. This process is repeated many times under a Monte Carlo Simulation. For example, the following Table 3 illustrates a single possible path of mortalities for the pool illustrated in Table 2:
Another trial under the Monte Carlo process is displayed in the Table 5 below:
The net cash flows of the life insurance policy assets which are purchased to collateralize, fund, or hedge the obligations on each BRM borrower are equal to death benefits received in each year less premiums required to be paid on the remaining surviving BRM borrowers.
For the BRM loan assets, the net present value of the BRM loans must be simulated in accordance with the above simulation of the mortalities since each BRM loan has cashflows which are contingent upon the death of the BRM borrower or borrowers. For each simulated death according the principles specified above, the cashflows under the BRM are equal to (1) minimum of the accreted BRM loan value or the market value of the house were the latter exceeds the strike price under the home mortality put; or (2) minimum of the market value of the home of the strike price under the mortality put where the home mortality put has been optimally exercised by the borrower.
Referring again to
In the preceding specification, the present invention has been described with reference to specific exemplary embodiments thereof. Although many steps have been conveniently illustrated as described in a sequential manner, it will be appreciated that steps may be reordered or performed in parallel. It will further be evident that various modifications and changes may be made therewith without departing from the broader spirit and scope of the present invention as set forth in the claims that follow. The description and drawings are accordingly to be regarded in an illustrative rather than a restrictive sense.